**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****          ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March31, 2005**

 

**OR**

 

**o****          ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from        to        .**

 

**Commission file number 001-16047**

 

**Advanced Power Technology, Inc.**

(Exact name of registrantas specified in its charter*)*

 
| **Delaware**                                                     | ** ** | **93-0875072**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or other  Jurisdiction of  Incorporation or Organization) |       | (I.R.S. Employer  Identification Number) |

 

**405 SWColumbia Street, Bend, Oregon 97702**

(Address ofprincipal executive offices and Zip Code)

 

**(541)382-8028**

(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes ý    No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes ý  No o

 

The number of shares ofthe Registrant’s Common Stock outstanding as of May 1, 2005 was 10,704,516 shares.

 

 

----

 

**ADVANCED POWER TECHNOLOGY, INC.**

**FORM 10-Q**

**TABLE OFCONTENTS**

** **
| **Part I**  | **Financial Information** | ** **                                                                                  |
|-------------|---------------------------|---------------------------------------------------------------------------------------------|
|        |                      |                                                                                        |   |
|        | Item 1.                   | Financial Statements:                                                                       |   |
|        |                      |                                                                                        |   |
|        |                      | Consolidated  Balance Sheets as of March 31, 2005 and December 31, 2004                     |   |
|        |                      |                                                                                        |   |
|        |                      | Consolidated  Statements of Operations for the three months ended March 31, 2005 and 2004   |   |
|        |                      |                                                                                        |   |
|        |                      | Consolidated  Statements of Cash Flows for the three months ended March 31, 2005 and 2004   |   |
|        |                      |                                                                                        |   |
|        |                      | Notes to Consolidated  Financial Statements                                                 |   |
|        |                      |                                                                                        |   |
|        | Item 2.                   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|        |                      |                                                                                        |   |
|        | Item 3.                   | Quantitative and Qualitative Disclosure About  Market Risk                                  |   |
| ** **  | ** **                | ** **                                                                                  | ** ** |
|        | Item 4.                   | Controls and Procedures                                                                     |   |
|        |                      |                                                                                        |   |
|        |                      |                                                                                        |   |
| **Part II** | **Other Information**     | ** **                                                                                  |
|        |                      |                                                                                        |   |
|        | Item 6.                   | Exhibits                                                                                    |   |
|        |                      |                                                                                        |   |
|        |                      | Signature                                                                                   |   |
|        |                      |                                                                                        |   |
|        |                      | Exhibits                                                                                    |   |

 

2

----

 

**ITEM 1.****FINANCIALSTATEMENTS**

 

**ADVANCED POWER TECHNOLOGY, INC.**

**CONSOLIDATED BALANCESHEETS**

**(In thousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                                                                                     | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
|                                                                                                                                                                                           |       |                |       |                   |       |
| **Assets**                                                                                                                                                                                     | ** ** | ** **          | ** ** | ** **             | ** ** |
| Current  assets:                                                                                                                                                                               |       |                |       |                   |       |
| Cash  and cash equivalents                                                                                                                                                                     |       | $                   | 1,442      |                   | $          | 4,149 |   |
| Short-term  investments in available-for-sale securities                                                                                                                                       |       | 10,099              |       | 11,675                 |       |
| Accounts  receivable, net of allowance of $160 (2005) and $192 (2004)                                                                                                                          |       | 8,633               |       | 10,044                 |       |
| Inventories,  net                                                                                                                                                                              |       | 13,401              |       | 14,647                 |       |
| Prepaid  expenses and other current assets                                                                                                                                                     |       | 2,211               |       | 2,196                  |       |
| Total  current assets                                                                                                                                                                          |       | 35,786              |       | 42,711                 |       |
| Property  and equipment, net of accumulated amortization and depreciation of $17,819  (2005) and $16,994 (2004)                                                                                |       | 11,368              |       | 11,357                 |       |
| Long-term  investments in available-for-sale securities                                                                                                                                        |       | 1,000               |       | 1,000                  |       |
| Other  assets                                                                                                                                                                                  |       | 55                  |       | 110                    |       |
| Intangible  assets, net of accumulated amortization of $3,346 (2005) and $3,030 (2004)                                                                                                         |       | 7,753               |       | 7,734                  |       |
| Goodwill                                                                                                                                                                                       |       | 15,570              |       | 15,570                 |       |
| Total  assets                                                                                                                                                                                  |       | $                   | 71,532     |                   | $          | 78,482 |   |
|                                                                                                                                                                                           |       |                |       |                   |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                  |       |                |       |                   |       |
| Current  liabilities:                                                                                                                                                                          |       |                |       |                   |       |
| Accounts  payable                                                                                                                                                                              |       | $                   | 2,745      |                   | $          | 4,143 |   |
| Accrued  expenses                                                                                                                                                                              |       | 2,517               |       | 2,193                  |       |
| Total  current liabilities                                                                                                                                                                     |       | 5,262               |       | 6,336                  |       |
| Other  long term liabilities                                                                                                                                                                   |       | 104                 |       | 108                    |       |
| Total  liabilities                                                                                                                                                                             |       | 5,366               |       | 6,444                  |       |
|                                                                                                                                                                                           |       |                |       |                   |       |
| Stockholders’  equity:                                                                                                                                                                    |       |                |       |                   |       |
| Preferred  stock, par value $.001, 1,000,000 shares authorized; no shares issued and  outstanding                                                                                              |       | —              |       | —                 |       |
| Common  stock, par value $.01, 19,000,000 shares authorized; 10,816,666 issued and  10,699,816 shares outstanding in 2005; 10,804,620 shares issued and  10,687,770 shares outstanding in 2004 |       | 108                 |       | 108                    |       |
| Additional  paid-in capital                                                                                                                                                                    |       | 89,739              |       | 89,138                 |       |
| Treasury  stock, at cost, 116,850 shares                                                                                                                                                       |       | (1,761              | )          | (1,761                 | )          |
| Deferred  stock compensation                                                                                                                                                                   |       | (56                 | )          | —                 |       |
| Accumulated  other comprehensive income                                                                                                                                                        |       | 468                 |       | 545                    |       |
| Accumulated  deficit                                                                                                                                                                           |       | (22,332             | )          | (15,992                | )          |
| Total  stockholders’ equity                                                                                                                                                               |       | 66,166              |       | 72,038                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                                               |       | $                   | 71,532     |                   | $          | 78,482 |   |

 

See accompanying notes to consolidated financialstatements.

 

3

----

 

**ADVANCEDPOWER TECHNOLOGY, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Inthousands, except per share amounts)**

**(Unaudited)**

** **
| ** **                                                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                  | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                                                        |       |                              |       |   |   |
| Revenues,  net                                                                              |       | $                                 | 14,132     |   | $ | 15,093 |   |
| Cost  of goods sold                                                                         |       | 10,110                            |       | 9,367 |   |
| Amortization  of technology rights and other charges                                        |       | 269                               |       | 274 |   |
| Total  cost of goods sold                                                                   |       | 10,379                            |       | 9,641 |   |
| Gross  profit                                                                               |       | 3,753                             |       | 5,452 |   |
| Operating  expenses:                                                                        |       |                              |       |   |   |
| Research  and development                                                                   |       | 1,167                             |       | 887 |   |
| Selling,  general and administrative                                                        |       | 3,959                             |       | 4,110 |   |
| Restructuring  charges                                                                      |       | 45                                |       | 206 |   |
| In-process  research and development charges                                                |       | 4,896                             |       | — |   |
| Total  operating expenses                                                                   |       | 10,067                            |       | 5,203 |   |
| Income  (loss) from operations                                                              |       | (6,314                            | )          | 249 |   |
| Interest  income, net                                                                       |       | 55                                |       | 40 |   |
| Other  expense, net                                                                         |       | (51                               | )          | (6 | ) |
| Income  (loss) before income taxes                                                          |       | (6,310                            | )          | 283 |   |
| Income  tax expense                                                                         |       | 30                                |       | — |   |
| Net  income (loss)                                                                          |       | $                                 | (6,340     | ) | $ | 283 |   |
|                                                                                        |       |                              |       |   |   |
| Net  income (loss) per share:                                                               |       |                              |       |   |   |
| Basic                                                                                       |       | $                                 | (0.59      | ) | $ | 0.03 |   |
| Diluted                                                                                     |       | (0.59                             | )          | 0.03 |   |
| Weighted  average number of shares used in the computation of net income (loss) per  share: |       |                              |       |   |   |
| Basic                                                                                       |       | 10,695                            |       | 10,516 |   |
| Diluted                                                                                     |       | 10,695                            |       | 11,171 |   |

 

See accompanying notes to consolidated financialstatements.

 

4

----

 

**ADVANCED POWER TECHNOLOGY, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

** **
| ** **                                                                                        | ** **        | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|-------------------|-----------------------------------|------------|
| ** **                                                                                        | ** **        | **2005**                          | ** ** | **2004** | ** ** |
| Cash  flows from operating activities:                                                            |              |                              |       |   |   |
| Net  income (loss)                                                                                |              | $                                 | (6,340     | ) | $ | 283 |   |
| Adjustments  to reconcile net income (loss) to net cash (used) provided by operating  activities: |              |                              |       |   |   |
| Depreciation                                                                                      |              | 826                               |       | 871 |   |
| Amortization  of intangible assets                                                                |              | 316                               |       | 270 |   |
| Inventory  provision                                                                              |              | 92                                |       | 102 |   |
| In-process  research and development charges                                                      |              | 4,896                             |       | — |   |
| Amortization  of deferred stock compensation                                                      |              | 18                                |       | 10 |   |
| Deferred  gain on sale-leaseback                                                                  |              | (4                                | )          | (4 | ) |
| Amortization  of investment discount                                                              |              | 2                                 |       | — |   |
| Changes  in operating assets and liabilities, net of effects of acquisitions:                     |              |                              |       |   |   |
| Accounts  receivable                                                                              |              | 1,524                             |       | (949 | ) |
| Inventories                                                                                       |              | 1,080                             |       | 79 |   |
| Prepaid  expenses and other assets                                                                |              | 56                                |       | 160 |   |
| Accounts  payable and accrued expenses                                                            |              | (1,303                            | )          | (392 | ) |
| Net  cash provided by operating activities                                                        |              | 1,163                             |       | 430 |   |
| Cash  flows from investing activities:                                                            |              |                              |       |   |   |
| Purchases  of available-for-sale securities                                                       |              | (3,450                            | )          | (3,000 | ) |
| Proceeds  from sale of available-for-sale securities                                              |              | 5,025                             |       | 2,150 |   |
| Acquisitions,  net of cash acquired                                                               |              | (4,985                            | )          | — |   |
| Purchase  of property and equipment                                                               |              | (492                              | )          | (764 | ) |
| Net  cash used by investing activities                                                            |              | (3,902                            | )          | (1,614 | ) |
| Cash  flows from financing activities:                                                            |              |                              |       |   |   |
| Payments  on capital lease obligations                                                            |              | (2                                | )          | (1 | ) |
| Proceeds  from exercise of stock options                                                          |              | 23                                |       | 109 |   |
| Net  cash provided by financing activities                                                        |              | 21                                |       | 108 |   |
| Effects of exchange  rate changes on cash                                                         |              | 11                                |       | (1 | ) |
| Net  change in cash and cash equivalents                                                          |              | (2,707                            | )          | (1,077 | ) |
| Cash  and cash equivalents at beginning of period                                                 |              | 4,149                             |       | 3,664 |   |
| Cash  and cash equivalents at end of period                                                       |              | $                                 | 1,442      |   | $ | 2,587 |   |
|                                                                                              |              |                              |       |   |   |
| Supplemental  disclosure of cash flow information:                                                |              |                              |       |   |   |
| Cash  paid during the period for:                                                                 | Interest          |                              | $          | 5 |   | $ | 33 |   |
|                                                                                              | Income  taxes-net |                              | 10         |   | 16 |   |
|                                                                                              |              |                              |       |   |   |
| Supplemental  disclosure of noncash activities:                                                   |              |                              |       |   |   |
| Unrealized  gain (loss) on short-term and long-term investments                                   |              | $                                 | 1          |   | $ | — |   |
| Issuance  of stock options for acquisitions                                                       |              | 570                               |       | — |   |

 

See accompanying notes to consolidated financialstatements.

 

5

----

 

**ADVANCED POWER TECHNOLOGY, INC.**

**NOTES****TO CONSOLIDATED FINANCIAL STATEMENTS**

**(In thousands, except share amounts)**

**(Unaudited)**

 

**Note 1. Basisof Presentation**

 

The accompanyingunaudited consolidated financial statements include normal recurringadjustments necessary for a fair presentation of Advanced Power Technology,Inc.’s (APT) interim results.  Theconsolidated financial statements and notes in this Form 10-Q are presented aspermitted by Regulation S-X, and as such, they do not contain certaininformation included in APT’s 2004 annual consolidated financial statements andnotes.  This Form 10-Q should be read in conjunctionwith APT’s consolidated financial statements and notes included in its AnnualReport on Form 10-K for the year ended December 31, 2004.  The financial information as of December 31,2004 is derived from the audited consolidated financial statements as filedwith APT’s Annual Report on Form 10-K for the year ended December 31, 2004.  The results of operations for the threemonths ended March 31, 2005 are not necessarily indicative of the resultsexpected for the entire fiscal year ending December 31, 2005.

 

APT’s financial quartersare 13 week periods. The first quarter of 2005 ended on April 3, 2005 and the firstquarter of 2004 ended on April 4, 2004. For convenience, the first quarters of 2005 and 2004 are both shown asended on March 31.

 

**Note 2.Summary of Significant Accounting Policies**

 

***(a)******          SalesReturns and Allowances***

 

The balances andchanges in reserve for warranties and sales returns for the three months ended March31, 2005 and 2004 are as follows:

 
| ** **                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|
| ** **                          | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                |       |                              |       |   |   |
| Balance  – beginning of period |       | $                                 | 716        |   | $ | 431 |   |
| Provisions                          |       | 790                               |       | 319 |   |
| Charge  offs                        |       | (827                              | )          | (437 | ) |
| Balance  – end of period       |       | $                                 | 679        |   | $ | 313 |   |

 

***(b)******           Stock-BasedCompensation***

 

APT has elected tocontinue to apply the prescribed accounting in Opinion 25 and provide therequired disclosures per SFAS 123 and SFAS 148. APT accounts for equityinstruments issued to non-employees in accordance with the provisions ofSFAS 123 and Emerging Issues Task Force consensus on Issue No. 96-18, “Accountingfor Equity Instruments that are Issued to Other than Employees, for Acquiringor in Conjunction with Selling Goods or Services.”

 

In December 2004,the FASB finalized SFAS No. 123R “Share Based Payment,” which will be effectivefor annual reporting periods beginning after June 15, 2005. The new standardwill require us to expense stock based compensation. Under SFAS No. 123R,we must evaluate and determine the appropriate fair value model to be used forvaluing share-based payments, the amortization method for compensation cost andthe transition method to be used at the date of adoption. We are currentlyevaluating the provisions of FAS 123R and expect that the adoption on January1, 2006 will have a material impact on the Company’s consolidated results ofoperations and earnings per share, as the stock based compensation expense willbe charged directly against our reported earnings. We do not expect theaccounting change to materially affect our liquidity as equity-basedcompensation is a non-cash expense.

 

6

----

 

Had APT determinedcompensation cost based on the fair value at the grant date for its stockoptions under SFAS 123, APT’s net income (loss) would have been the proforma amounts indicated in the table below.

 
| ** **                                                                                 | ** ** | **Three Months  Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                                                       |       |                              |       |   |   |
| Net  income (loss), as reported                                                            |       | $                                 | (6,340     | ) | $ | 283 |   |
| Add:  Stock based compensation included in reported net income (loss)                      |       | 18                                |       | 10 |   |
| Deduct:  Stock based compensation determined under fair value based method for all  awards |       | (249                              | )          | (222 | ) |
| Pro  forma net income (loss)                                                               |       | $                                 | (6,571     | ) | $ | 71 |   |
|                                                                                       |       |                              |       |   |   |
| Income  (loss) per share:                                                                  |       |                              |       |   |   |
| Basic  – as reported                                                                  |       | $                                 | (0.59      | ) | $ | 0.03 |   |
| Basic  – pro forma                                                                    |       | (0.61                             | )          | 0.01 |   |
|                                                                                       |       |                              |       |   |   |
| Diluted  – as reported                                                                |       | $                                 | (0.59      | ) | $ | 0.03 |   |
| Diluted  – pro forma                                                                  |       | (0.61                             | )          | 0.01 |   |

 

The effects ofapplying SFAS 123 in this pro forma disclosure are not indicative of futureamounts and additional awards are anticipated in future years. The fair valueof the compensation costs reflected in the above pro forma amounts wasdetermined using the Black-Scholes option pricing model and the weightedaverage assumptions as follows:

 
| ** **               | ** ** | **2005**  | ** ** | **2004** | ** ** |
|--------------------------|------------|-----------|------------|----------|------------|
|                     |       |      |       |     |       |
| Risk-free  interest rate |       | 4.0       | %          | 3.0      | %          |
| Expected  dividend yield |       | 0         | %          | 0        | %          |
| Expected  life           |       | 6.5 years |       | 5 years  |       |
| Volatility               |       | 82        | %          | 100      | %          |

 

***(c)******           NetIncome (Loss) Per Share***

 

Basic net income (loss)per share is computed using the weighted average number of shares of commonstock outstanding for the period. Diluted net income per share is computedusing the weighted average number of shares of common stock and dilutivepotential common shares related to stock options and warrants outstandingduring the period.  Anti-dilutivepotential common shares are excluded from the diluted net income share calculation.  Dilutive net loss per share excludes allpotential common shares from the calculation as the impact would beanti-dilutive.

 

7

----

 

Incremental dilutiveshares included in the calculation of diluted net income per share andincremental anti-dilutive shares that were excluded from the calculation ofdiluted net income per share for the three months ended March 31, 2005 and 2004are summarized in the following table.

 
| ** **                                                                        | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                              |       |                               |       |   |   |
| Incremental  dilutive shares included in diluted net income per share calculation |       | —                             |       | 655,000 |   |
| Anti-dilutive  shares excluded from diluted net loss per share calculation        |       | 1,321,000                          |       | 554,000 |   |

 

***(d)******           Goodwilland Intangibles***

 

                APT values goodwill and intangibleassets in accordance with SFAS 142, “Goodwill and Other Intangible Assets.” Thecosts of internally developed intangible assets are expensed as incurred.  The costs of acquired intangible assets arerecorded at fair value at acquisition. Intangible assets with finite lives areamortized using the straight-line method over their estimated useful lives, themajority of which was estimated at ten years, and evaluated for impairment inaccordance with SFAS 144. Amortization of intangible assets was approximately $316and $269 in the first three months of 2005 and 2004, respectively. Excludingthe impact of any future acquisitions, amortization of technology rights willbe $1,262 in 2005, $1,150 in 2006 and 2007, and $1,076 in 2008 and 2009.

 

***(e)******           IncomeTaxes***

 

Income taxes areaccounted for under the asset and liability method. Under the asset andliability method, deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin income in the period that includes the enactment date. A valuation allowanceis established when necessary to reduce deferred tax assets to the amountexpected to be realized. During the fourth quarter of 2003, the Companydetermined that a full valuation allowance should be recorded against its netdeferred tax assets. As of March 31, 2005, the Company still maintains a fullvaluation allowance against its net deferred tax assets.

 

***(f)******            Reclassifications***

 

Certain reclassifications have been made to the prior year statement of cash flows to conform to current presentation. These changes had no impact on the previously reported balance sheet, results of operations, or shareholders’ equity.  The reclassification related to certain auction rate securities which are now classified as short-term investments in available-for-sale securities and which had previously been classified as cash and cash equivalents. The amounts for such auction rate securities as of March 31, 2005 and December 31, 2004 were $7,300 and $7,875, respectively.

 

**Note 3.Acquisitions**

 

On December 22, 2004Advanced Power Technology, Inc. (APT) entered into a definitive agreement andplan of merger with PowerSicel, Inc. The acquisition was completed onJanuary 7, 2005 and the company was re-named to Advanced Power TechnologyColorado.

 

Under the terms ofthe agreement, APT paid approximately $5.4 million in cash from operations inexchange for all of the existing shares of PowerSicel, issued 63,525 APT stockoptions in exchange for the 

 

8

----

 

PowerSicel stock optionsand issued 19,402 APT stock options for the retention of key employees. PowerSicelInc. was determined to be a development stage company, in accordance with EITF98-3 “Determining Whether a Nonmonetary Transaction Involves Receipt ofProductive Assets or of a Business.” Therefore, the transaction was considereda purchase of tangible and intangible assets, which were accounted for inaccordance with SFAS 142 “Goodwill and Other Intangible Assets.”  APT obtained a third party valuation study toestimate the fair value of the acquired intangible assets.  APT began to consolidate the financialresults of PowerSicel on January 7, 2005. The purchase price for accounting purposes was derived as follows:

 
| ** **            | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
|-----------------------|------------|------------|------------|----------------|------------|
| Cash  paid at closing |       |       |       | $              | 5,387      |   |
| Exchanged  options    |       | 63,525     |       | 458            |       |
| Retention  options    |       | 19,402     |       | 112            |       |
| Direct  costs         |       |       |       | 113            |       |
| Total  purchase price |       |       |       | $              | 6,070      |   |

 

All vested and unvested PowerSiceloptions exchanged for APT options and retention options issued by APT areincluded as part of the purchase price based on their fair value.  The estimated fair value of the options isbased upon the Black-Scholes model using the following assumptions:

 
| ** **               | ** ** | **Exchanged   Options** | ** ** | **Retention   Options** | ** ** |
|--------------------------|------------|-------------------------|------------|-------------------------|------------|
| Expected  life           |       | 3.0 years               |       | 6.25 years              |       |
| Expected  volatility     |       | 69                      | %          | 82                      | %          |
| Risk-free  interest rate |       | 3.4                     | %          | 4.0                     | %          |
| Expected  dividend yield |       | 0.0                     | %          | 0.0                     | %          |

 

PowerSicel’s expertise in silicon carbide and othercompound semiconductor technology and products complement APT’s currentportfolio of RF products which operate at frequencies ranging from 1 MHz to 4GHz and are sold into applications such as semiconductor capital equipment,medical imaging, radar, avionics and wireless communications. The acquisitionadds valuable development capability to APT’s core capability in discrete and RFpower transistors allowing APT to better serve its current markets and toexpand into new markets.

 

Theallocation of purchase price was as follows:

 
| Working  capital                                         |   | $     | 430    |   |
|----------------------------------------------------------|--------|-------|--------|--------|
| Property  and equipment                                  |   | 344   |   |
| Deferred  compensation on unvested stock options assumed |   | 66    |   |
| Acquired  in-process research and development            |   | 4,896 |   |
| Acquired  intangible assets                              |   | 334   |   |
| Allocated  purchase price                                |   | $     | 6,070  |   |

 

In connection with this acquisition, the APT recordeda charge of $4,896 for the write-off of in-process research and development(IPR&D).  The value assigned toIPR&D related to research projects for which technological feasibility hadnot yet been established and for which there was no other feasible alternativeuse for the technology.  In addition, APTrecorded intangible assets of $223 and $111 for PowerSicel’s assembledworkforce and for certain employment contracts of key PowerSicel executives,respectively. The assembled workforce intangible asset will be amortized overthree years and the employment contracts intangible asset will be amortizedover one year, reflecting the expected life of the assets.  The IPR&D and intangible asset amountsare not deductible for tax purposes.

 

The value of IPR&D was determined by estimatingthe net cash flows from the sale of products with silicon carbide technologyand discounting the net cash flows back to their present value using a riskadjusted interest rate of 

 

9

----

 

30%.  Theestimated net cash flows were based on management’s estimates of relatedrevenues, costs of goods sold, operating expenses, income taxes, and additionalcosts to completion for the in-process technology.

 

The value of the assembled workforce was determined byestimating the cost to independently recruit, hire, and train the acquired PowerSicelworkforce.  The value of the employmentcontracts was determined by calculating the difference between estimated netcash flows with and without the employment contracts over a two year period.  The net cash flows were discounted back totheir present value using a risk adjusted interest rate of 23%.

 

The nature of the efforts to develop the in-processtechnology into commercially viable products principally relate to thecompletion of all designing, prototyping, verification and testing activities thatare necessary to establish that the product can be produced to meet its designspecifications, including function, features, and technical performancerequirements.  PowerSicel had one mainproduct group under development at the acquisition date that met the minimumdevelopment requirements for IPR&D projects.  The project included the commercialization ofsilicon carbide transistors.  The projectwas approximately 80% complete at the time of the acquisition and was expectedto be complete within nine to twelve months. The estimated aggregate cost to complete the project was $260.

 

Pro forma resultsof operations have not been presented for this acquisition because the effectswere not material on an individual or aggregate basis.

 

**Note 4.Restructuring Charges**

 

Restructuringcosts are accounted for in accordance with SFAS 146, “Accounting for CostsAssociated with Exit or Disposal Activities.” A liability for a cost associatedwith an exit or disposal activity is recognized and measured at fair value inthe period the liability is incurred, except for liabilities related to ongoingservice requirements which are recognized over the service period. All otherrestructuring charges are directly expensed in the period they are paid.

 

As part of management’scost reduction efforts, the Company announced in November of 2003 restructuringactions intended to improve manufacturing efficiencies and lower administrativecosts. The actions include consolidation of certain administrative functions,rationalization of internal and external assembly and test manufacturing, andthe reduction of rent expense through the purchase and resale of one of the twobuildings currently occupied by the Company’s Santa Clara, Californiasubsidiary. These announced actions were in addition to previously disclosedplans to consolidate the Company’s wafer fabrication plant in Montgomeryville,Pennsylvania to Bend, Oregon. Total restructuring related charges recognized in2004 were $558, of which $206, $115, $38 and $199 were recognized in the first,second, third and fourth quarters of 2004, respectively.

 

The totalseverance related charge recognized in 2004 was $103, which was recognized as $65and $38 in the first and second quarters of 2004, respectively. The severancecharge related to already separated personnel and personnel costs associatedwith benefits expected to be paid upon completion of certain eligible transferactivities. Additional restructuring costs of $375 associated with costs toexit certain production activities were also recognized in 2004, of which $141,$77, $38, and $119 were recognized in the first, second, third and fourthquarters of 2004, respectively.  Thecharges relate to accelerated depreciation on certain production relatedequipment to be abandoned after shutdown and contractual closing costs.

 

The buildingpurchase is reported as an asset held for sale and is being marketed for saleas APT no longer requires the space. In accordance with SFAS 144, an asset heldfor sale is carried at net estimated fair value. As such, APT recorded animpairment charge for the building in the fourth quarter of 2004 and 2003 ofapproximately $80 and $350, respectively. Fair value was estimated based oncomparable sales data of similar commercial space in the area. The net carryingvalue of the building as of March 31, 2005 was approximately $930 and isincluded as a component of other current assets.

 

During the firstquarter of 2005 an additional $45 was recognized in restructuring charges. Thecharges were associated with additional severance costs.  The changes in the reserve for restructuringbalance for the three months ended March 31, 2005 and 2004 are shown in thetable below. Certain of the restructuring charges were expensed as incurred andtherefore are not included in the provision.

 

10

----

 
| ** **                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|
| ** **                          | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                |       |                              |       |   |   |
| Balance  – beginning of period |       | $                                 | 60         |   | $ | 178 |   |
| Provisions                          |       | —                            |       | 128 |   |
| Charge  offs                        |       | (6                                | )          | (151 | ) |
| Balance  – end of period       |       | $                                 | 54         |   | $ | 155 |   |

 

**Note 5. ComprehensiveIncome (loss)**

 

Comprehensive income(loss) is the total of net income (loss) and all other non-owner changes inequity. Comprehensive income (loss) includes foreign currency translations andunrealized gains and losses from investments, as presented in the followingtable.

 
| ** **                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                               | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                     |       |                              |       |   |   |
| Net  income (loss)                                       |       | $                                 | (6,340     | ) | $ | 283 |   |
|                                                     |       |                              |       |   |   |
| Other  comprehensive income (loss), net of tax:          |       |                              |       |   |   |
| Unrealized  gain/(loss) on available for sale securities |       | 1                                 |       | — |   |
| Foreign  currency translation adjustment                 |       | (78                               | )          | 91 |   |
| Comprehensive  income (loss)                             |       | $                                 | (6,417     | ) | $ | 374 |   |

 

**Note 6. Inventories,net**

 
| ** **        | ** ** | **March 31,   2005** | ** ** | **December 31,   2004** | ** ** |
|-------------------|------------|----------------------|------------|-------------------------|------------|
|              |       |                 |       |                    |       |
| Raw  materials    |       | $                    | 2,862      |                    | $          | 3,003 |   |
| Work  in process  |       | 6,325                |       | 7,061                   |       |
| Finished  goods   |       | 4,214                |       | 4,583                   |       |
| Inventories,  net |       | $                    | 13,401     |                    | $          | 14,647 |   |

 

**Note 7. SegmentInformation**

 

APT operates in one segment and is engaged in themanufacture and marketing of high-performance power semiconductors and modulesfor switching and RF applications. Overall, our revenue by geographic area forthe first quarter of 2005 was 61.7% in North America, 21.4% in Europe and 16.9%in Asia, compared to 65.4% in North America, 14.5% in Europe, and 20.1% in Asiaduring the first quarter of 2004. We allocated revenue geographically based onthe location to which we ship our products.

 

**Note 8. Line of Credit**

 

On March 31, 2005, we obtained a $10 million revolvingline of credit with Silicon Valley Bank. We currently do not have any advancesunder this line of credit.  The Companypaid commitment fees of 20 basis points upon closing and will pay 20 basispoints per year on the unused portion of the line of credit, payable quarterly.

 

11

----

 

Amounts borrowed under the credit agreement aresecured by certain tangible and intangible assets of the Company. The creditagreement expires on June 30, 2006, at which time all amounts borrowed andrelated interest are immediately payable if the agreement is not renewed.

 

**Note 9. Commitments and Contingencies**

 

From time to timethe Company is involved in various legal matters that arise out of the ordinaryconduct of our business, including those related to litigation overintellectual property rights, commercial transactions, contracts, productliability, environmental, safety and health, and employment matters.  The Company is not currently involved in anylegal proceedings. The Company accrues loss contingencies in connection withits litigation when it is probable that a loss has occurred and the amount ofthe loss can be reasonably estimated.

 

**ITEM 2****. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

This discussion and analysis is intended to be readin conjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations set forth in our Annual Report on Form 10-K for theyear ended December 31, 2004.

 

**Forward-looking Statements and Risk Factors Affecting Business andResults of Operations**

 

All statements and trend analyses contained in thisitem and elsewhere in this report on Form 10-Q relative to the futureconstitute “forward-looking” statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-statements are subject to thebusiness and economic risks faced by us and our actual results of operationsmay differ materially from those contained in the forward-looking statements.In addition, results of operations for the periods discussed below should not beconsidered indicative of the results to be expected in any future period andfluctuations in operating results might result in fluctuations in the marketprice of our common stock. Our quarterly and annual operating results may varysignificantly depending on many factors, including but not limited to theability of subcontractors and key vendors to meet their delivery commitments;unfavorable changes in industry and competitive conditions; our mix of productshipments; the accuracy of our customers’ forecasts; the effectiveness of ourefforts to control and reduce costs; and other risks detailed in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations - RiskFactors Affecting Business and Results of Operations” in our Annual Report onForm 10-K for the year ended December 31, 2004, filed with the Securities andExchange Commission.

 

**BusinessOverview**

 

We are a leading designer, manufacturer and marketer ofhigh-performance RF and switching power semiconductors. We are primarilyfocused on the high-power, high-speed segment of the power semiconductormarket. Power semiconductors function as power amplifiers and power switches.They increase system efficiency and reliability by precisely managing andregulating electricity and converting it into the form required by electricaland electronic products. Our products permit the design of more compact endproducts and improve system features and functionality. Our products are foundin diverse applications, such as F-22 fighter cockpits, the Boeing 777 back-uppower system, the International Space Station, air traffic control radarsystems, semiconductor capital equipment, MRI systems, arc welding equipment,industrial lasers, solar power panels and wireless communications base stations.

 

Power semiconductors generally dissipate more than one watt of powerand have a broad range of frequency capabilities. We primarily focus onhigh-power, high-speed devices that dissipate at least several hundred watts ofpower and require operating frequencies greater than 20 kHz, or 20,000 cyclesper second (e.g., the product may switch on and off up to 20,000 times persecond).

 

Certainmarkets we serve, such as the semiconductor capital equipment andcommunications and data processing markets, have historically been quitecyclical. During periods of contraction in the these cyclical markets, we haveexperienced downward pressure on our revenues and gross margins. We haveattempted to reduce this 

 

12

----

 

volatility throughacquisitions and product development in less cyclical markets, such as themilitary aerospace and medical equipment markets, and by rigorously managingour expenses through increased offshore production.

 

We sell our products in North America, Europe, and Asia primarilypursuant to customer purchase orders. We sell through a network of independentsales representatives and distributors. We recognize revenue upon shipment ofour products. We have operations in Bend, Oregon, Santa Clara, California,Montgomeryville, Pennsylvania, Boulder, Colorado, and Bordeaux, France. We alsomake use of subcontract manufacturers for the fabrication of our wafers and forassembly and test operations. Our locations are more fully described in “Business—Properties”in our 2004 Form 10-K.

 

In 2002, we acquired GHz Technology and the product lines and certainassets of Microsemi RF Products to help us further penetrate the markets for RFdevices. We believe that these acquisitions have positioned us as a leadingsupplier in bipolar RF power transistors and added substantial RF technology,engineering, manufacturing and marketing capabilities.

 

In September 2004 and January 2005, we acquired theassets of two development stage businesses. In September 2004, we paid $175 in cash from operations for the assetsof Zeus Semiconductor, Inc., including prototype inventories, equipment,patents, and other intellectual property. In January 2005, we acquiredPowerSicel, Inc. for approximately $5.4 million, from existing cash andmarketable securities, in exchange for all of the existing shares ofPowerSicel, 63,525 APT stock options in exchange for the PowerSicel stockoptions and 19,402 APT stock options for the retention of key employees.PowerSicel’s and Zeus Semiconductor’s combined expertise in silicon carbide andother compound semiconductor technology and products complement APT’s currentportfolio of RF products which operate at frequencies ranging from 1 MHz to 4GHz and are sold into applications such as semiconductor capital equipment,medical imaging, radar, avionics and wireless communications. We believe theseacquisitions add valuable development capability to APT’s core capability in RFpower transistors allowing APT to better serve its current markets and toexpand into new markets.

 

As a result of the prior acquisitions made, we recorded acquisitionrelated charges for amortization of intangible assets and deferred compensationamortization of $1,098 in 2004, of which $1,086 was included in cost of goods soldand $12 in operating expenses. In 2004, we acquired the assets, includingprototype inventories, equipment, patents, and other intellectual property froma development stage business, Zeus Semiconductor, Inc. As a result of thistransaction, during the third quarter of 2004 we recorded acquisition relatedcharges for purchased IPR&D of $170. Also recorded in 2004 was $558 ofrestructuring related charges included in operating expenses. These chargesincluded severance related to downsizing and organizational changes we began in2003. The charges also include an additional impairment charge on theadministrative building we purchased in 2003, as well as costs to exit certainproduction activities. The latter charges relate to accelerated depreciation oncertain production related equipment to be abandoned after shutdown andcontractual closing costs. During the third and fourth quarters of 2004 we alsoincurred $225 of charges in connection with the filing and subsequentwithdrawal of a registration statement. The total amount of these items net oftaxes was $2,028. The total charges by quarter were pre-tax $486, $395, $658,$512 and after tax $486, $395, $645, $502, in the first, second, third, andfourth quarters, respectively.

 

In 2005, we recorded acquisition related charges for amortization ofintangible assets and deferred compensation amortization of $325, of which $269was included in cost of goods sold and $56 in operating expenses.  In connection with our January 2005acquisition of PowerSicel, Inc., we recorded in-process research anddevelopment charges of $4,896.  Alsorecorded in 2005 was $45 of restructuring related charges included in operatingexpenses. These charges were associated with additional severance related todownsizing and organizational changes we began in 2003.  The total charges for the first quarter 2005pre-tax and after tax were $5,266 and $5,259, respectively.

 

**OurMarkets**

 

We operate on a worldwide basis. As such, our operations are affectedby global, regional and industry-specific economic and political factors.Overall, our revenue by geographic area for the first quarter of 2005 was 61.7%in North America, 21.4% in Europe and 16.9% in Asia, compared to 65.4% in NorthAmerica, 14.5% in Europe, and 20.1% in Asia during the first quarter of 2004.  We allocate revenue geographically based onthe location to which we ship our 

 

13

----

 

products. Themarkets for our products are diversified, and include military and aerospace,semiconductor capital equipment, medical and industrial, and communications anddata processing.

 

We believe demand is being driven by the emergence of new applicationsfor higher power, higher frequency semiconductors that more precisely managepower, and also by the need to increase performance and improve power qualityfor existing applications. We believe demand is also being driven by the needfor more efficient energy use resulting from rising energy costs, governmentmandates and environmental concerns.

 

**Business Strategies**

 

Our goal is to be theworld leader in providing high-performance power semiconductors for high-power,high-speed applications.  To achieve ourgoal, we intend to:

 

•      Increaseour penetration of core markets and customers and expand globally;

 

•      Continueto develop and commercialize leading-edge technology for new and existingapplications;

 

•      Capitalizeon and expand our RF expertise;

 

•      Continueto optimize manufacturing operations, including the use of foundries andoffshore production; and

 

•      Seekto enhance growth through selective acquisitions

 

**CriticalAccounting Policies and Estimates**

 

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith U.S. generally accepted accounting principles. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenue and expenses, and relateddisclosures of contingent assets and liabilities. On an on-going basis, weevaluate our estimates, including those related to product returns and warrantyobligations, allowance for doubtful accounts, excess and obsolete inventories,income taxes, valuation of goodwill and intangible assets with indefinitelives, valuation of long-lived assets, and contingencies and litigation. Webase our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities and the timing of revenue recognition that are not readilyapparent from other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

We believe the followingcritical accounting policies involve more significant judgments and estimatesused in the preparation of our consolidated financial statements.

 

***Revenue Recognition, Sales Allowances, Returns and WarrantyObligations***

 

We recognize revenue whenproducts are shipped and the customer takes ownership and assumes risk of loss,collection of the relevant receivable is probable, persuasive evidence of anarrangement exists, and the sales price is fixed or determinable. In general,we provide for a one-year repair or replacement warranty on our products. Weuse independent distributors to sell some of our products. Our distributorshave certain stock rotation rights which allow them to rotate up to 5% of theirproducts every six months in exchange for an order of an equal amount of newproduct. In addition, we may on a case-by-case basis grant to distributorscertain price protections and allowances. Upon shipment, we record an allowancefor the estimated cost that may be incurred for product warranty and salesreturns based on historical experience and any contractual requirements withour distributors.

 

While we engage inextensive product quality programs and processes, including actively monitoringand evaluating the quality of our component suppliers, our warranty obligationis affected by product non-conformance rates, material usage and servicedelivery costs incurred in correcting a product non-conformance. Should actual 

 

14

----

 

product non-conformancerates, material usage, service delivery costs, or distributor returns differfrom our estimates, revisions to the estimated revenue provision would berequired.

 

***Allowance for Doubtful Accounts***

 

We maintain an allowancefor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. We regularly review the adequacy of theallowance after considering the size of the accounts receivable balance,historical bad debts, the customer’s expected ability to pay and our collectionhistory with each customer. We review significant individual accounts that arepast due to determine whether an allowance should be made based on thesefactors. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required.

 

***Excess and Obsolete Inventories***

 

Inventories are stated atthe lower of standard cost (approximates actual cost on a first-in, first-outbasis) or market (net realizable value). We adjust inventory costs forestimated unmarketable (excess) or obsolete inventory to estimated netrealizable value based upon assumptions about future demand and marketconditions. We establish reserves for excess component order cancellation costsbased on estimated net realizable value of the components purchased and anyadditional cancellation charges. We evaluate historical usage of the product,current customer demand, purchase commitments and forecasted usage of theproduct. If actual market conditions are less favorable than those projected bymanagement, additional adjustments or reserves may be required.

 

***Income Taxes***

 

We record a valuationallowance to reduce our deferred tax assets to the amount that is more likelythan not to be realized. We consider future taxable income and ongoing prudentand feasible tax planning strategies in assessing the need for the valuationallowance. In the event we were to determine that we would be able to realizeour deferred tax assets in the future in excess of our net recorded amount, anadjustment to decrease the valuation allowance would increase income in theperiod such determination was made. Should we determine that we would not beable to realize all or part of our net deferred tax asset in the future, anadjustment to increase the valuation allowance would be charged to income inthe period such determination was made. As of March 31, 2005, we had a fullvaluation allowance recorded against our net deferred tax assets.

 

***Valuation of Goodwill and Intangible Assets with IndefiniteLives***

 

We value goodwill andintangible assets with indefinite lives in accordance with Statement ofFinancial Accounting Standards No. (SFAS) 142 ‘‘Goodwill and Other IntangibleAssets.’’ Currently we carry a goodwill balance in connection with previousacquisitions, but have no other intangible assets with indefinite lives. Weannually review goodwill for impairment and when events or circumstancesindicate the carrying value of the asset might exceed its current fair value.We determine fair value using discounted cash flow analysis and otheracceptable valuation methodologies such as market multiples and comparabletransactions. This requires us to make assumptions and estimates regardingindustry economic factors and future profitability. It is our policy to conductimpairment testing based on our most current business plans, which reflectchanges we anticipate in the economy and industry. If actual results are not consistentwith our assumptions and judgments, we could be exposed to a materialimpairment charge as a result of writing down the carrying value of goodwill.

 

***Valuation of Long-Lived Assets***

 

We value long-livedassets, including intangible assets with finite lives, in accordance with SFAS144 ‘‘Accounting for the Impairment or Disposal of Long-Lived Assets.’’ Weevaluate our long-lived assets for impairment whenever events or changes incircumstances indicate that the carrying amount may not be recoverable. Wedetermine the potential impairment using undiscounted cash flow analysis, whichrequires us to make certain assumptions and estimates regarding industryeconomic factors and future profitability. It is our policy to conductimpairment testing based on our most current business plans, which reflectchanges we anticipate in the economy and industry. If actual results are notconsistent with our assumptions and judgments, we could be exposed to amaterial

 

15

----

 

impairment charge as aresult of writing down the carrying value of long-lived assets. If the assetgroup is determined to be unable to recover the carrying amount of its assets,then intangible assets are written down first, followed by the other long-livedassets of the operation, to fair value. Fair value is determined based ondiscounted cash flows or appraised values, depending on the nature of theassets. Long-lived assets considered held for sale are valued at the lower ofhistorical cost or fair value less costs to sell. Such assets are notdepreciated while so classified.

 

***Contingencies and Litigation***

 

We are subject tothe possibility of various loss contingencies arising in the ordinary course ofbusiness. We consider the likelihood of loss or impairment of an asset or theincurrence of a liability, as well as our ability to reasonably estimate theamount of loss in determining loss contingencies. An estimated loss contingencyis accrued when it is probable that an asset has been impaired or a liabilityhas been incurred and the amount of loss can be reasonably estimated. Weregularly evaluate current information available to us to determine whethersuch accruals should be adjusted.

 

**Resultsof Operations**

 

The following tablepresents our consolidated statement of operations data for the periodsindicated as a percentage of net revenue:

 
| ** **                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                           | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                 |       |                              |       |   |   |
| Revenues,  net                                       |       | 100.0                             | %          | 100.0 | % |
| Cost  of goods sold                                  |       | 71.5                              |       | 62.1 |   |
| Amortization  of technology rights and other charges |       | 1.9                               |       | 1.8 |   |
| Total  cost of goods sold                            |       | 73.4                              |       | 63.9 |   |
| Gross  profit                                        |       | 26.6                              |       | 36.1 |   |
| Operating  expenses:                                 |       |                              |       |   |   |
| Research  and development                            |       | 8.3                               |       | 5.9 |   |
| Selling,  general and administrative                 |       | 28.0                              |       | 27.2 |   |
| Restructuring  charges                               |       | 0.3                               |       | 1.4 |   |
| In-process  research and development charges         |       | 34.7                              |       | — |   |
| Total  operating expenses                            |       | 71.3                              |       | 34.5 |   |
| Income  (loss) from operations                       |       | (44.7                             | )          | 1.6 |   |
| Interest  income and other expense, net              |       | —                            |       | 0.3 |   |
| Income  (loss) before income tax benefit             |       | (44.7                             | )          | 1.9 |   |
| Income  tax benefit                                  |       | 0.2                               |       | — |   |
| Net  income (loss)                                   |       | (44.9                             | )%         | 1.9 | % |

 

*Revenue.* Revenue for the firstquarter of 2005 was $14.1 million, down 6.4% from $15.1 million in the firstquarter of 2004 and sequentially down 11.8% from $16.0 million in the fourthquarter of 2004, with both decreases primarily attributable to lower volumeshipments.

 

The 6.4% decline in revenue over the prior yearquarter was primarily due to a 64.0% decline in revenue in the semiconductorcapital equipment market, partially offset by a 19.9% increase in revenue inour industrial/medical market and a 32.1% increase in our military/aerospacemarket. The decline in revenue in the semiconductor capital equipment market isdue to both reduced end market demand and an inventory correction underway atour customers.  We believe that theinventory correction underway at our customers is substantially complete andthat we will return to sequential revenue growth in this market in the secondquarter of 2005.

 

16

----

 

The 11.8% sequential decline in revenue was primarilydue to a 22.4% decline in revenue in the semiconductor capital market, a 22.8%decline in the military/aerospace market, a 11.9% decline in theindustrial/medial market, partially offset by a 10.1% increase in thecommunications and data processing market. The decline in the military/aerospace market was expected as wecompleted a large radar order and shipped $2.8 million of product in the fourthquarter of 2004.  We expect to seerevenue growth in this market in the second half of 2005 primarily due to newdesign wins moving into production.  Thedecline in the industrial/medical market was due to an inventory correctiontaking place at one of our key customers serving this market.  We believe this correction will be completeby mid 2005. Our revenue in the communication and data processing marketbenefited from stable Asia telecommunications demand and shipments related to alarge server program on business we won from a competitor.

 

Overall, our revenue by geographic area for the firstquarter of 2005 was 61.7% in North America, 21.4% in Europe and 16.9% in Asia,compared to 65.4% in North America, 14.5% in Europe, and 20.1% in Asia duringthe first quarter of 2004. Revenues of our higher margin RF products were 47.1%in the first quarter of 2005 compared to 49.1% in the first quarter of 2004.

 

*Gross Profit*. Gross profit forthe first quarter of 2005 was 26.6% compared to 36.1% in first and fourth quartersof 2004. Excluding acquisition related non-cash amortization of the technologyassets acquired, gross profit was 28.5% in the first quarter of 2005 comparedto 37.9% in the first quarter of 2004 and 37.8% in the fourth quarter of 2004.  The decline in gross profit margin over theprior year quarter and sequentially is due to reduced fixed cost absorption on lowerproduction volumes, lower manufacturing yields, higher product returns, and aless favorable product mix on lower RF and semiconductor capital equipmentrelated revenue.  Our return provision asa percentage of total revenues increased to 5.3% in the first quarter of 2005from 2.1% in the first quarter of 2004, contributing approximately $480,000 to theoverall decline in gross margin. The higher returns were the result of twospecific customer quality related product returns, which we believe have nowbeen resolved. The gross margin deterioration was also attributable toabnormally low wafer manufacturing yields on certain products made in thequarter and lower factory fixed absorption at our Bend, Oregon facility. Theyield issues were identified in the quarter, but not until after productionlosses of approximately $200,000 were incurred.  The main cause of the yield losses incurredhas since been resolved.  In addition, asthe Company experienced sequential revenue declines in both the fourth quarterof 2004 and first quarter of 2005, we took actions to limit inventory build upby lowering orders from vendors and lowering production levels. While thishelped the Company to lower overall inventory by $1.2 million from the fourthquarter of 2004 to the first quarter of 2005 even while our revenues declinedby $1.9 million, the lower production had a negative impact on our margins. Weexpect to be impacted by the lower production levels into the second quarter of2005, but not to the same degree as the first quarter of 2005.

 

*Researchand Development Expense.* Our research and development expenses were $1.2 million in the firstquarter of 2005 compared to $887,000 in the first quarter of 2004 and $1.2million in the fourth quarter of 2004, or approximately 8.3%, 5.9%, and 7.7% ofrevenues, respectively. The increase in research and development spending overthe prior year quarter is due to increased payroll expense for additionalpersonnel dedicated to research and development activities and higher spendingon supplies and materials. The increase in the percentage of revenue in thefirst quarter of 2005 over the prior year quarter is primarily due to our higherspending levels in 2005.  The sequentialincrease in the percentage of revenue is primarily due to lower revenue levelsin the first quarter of 2005.  TheCompany plans to continue its research and development programs leading to theintroduction of new products for use in both switching and RF applications. Therefore,we expect the level of research and development expenses to be approximately 7.5%over sustained periods of time.

 

*Selling,General and Administrative Expense.* Selling, general, and administrativeexpenses were $4.0 million in the first quarter of 2005 compared to $4.1million in the first quarter of 2004, and $3.8 million in the fourth quarter of2004, or approximately 28.0%, 27.2%, and 23.5% of revenues, respectively.  Excluding commissions, which vary withrevenue, and legal fees associated with a settled patent litigation matter, ourselling, general, and administrative expenses in the first quarter of 2005,first quarter of 2004, and fourth quarter of 2004 would have been approximately$3.3 million, $2.9 million and $3.1 million, respectively.  The increase in selling, general, andadministrative expenses over the prior year quarter is primary due to higheraccounting fees associated with Sarbanes-Oxley compliance, costs associatedwith our new office in Shenzen China, and additional selling, general, andadministrative expenses from our 

 

17

----

 

first quarter acquisitionof PowerSicel, Inc.  The sequentialincrease in selling, general, and administrative expenses is primary due to ourfirst quarter acquisition of PowerSicel, Inc.

 

*RestructuringActivities:* As part of management’s cost reduction efforts,the Company announced in November of 2003 restructuring actions intended toimprove manufacturing efficiencies and lower administrative costs. The actionsinclude consolidation of certain administrative functions, rationalization ofinternal and external assembly and test manufacturing, and the reduction ofrent expense through the purchase and resale of one of the two buildings currentlyoccupied by the Company’s Santa Clara, California subsidiary. These announcedactions were in addition to previously disclosed plans to consolidate theCompany’s wafer fabrication plant in Montgomeryville, Pennsylvania to Bend,Oregon. Total restructuring related charges recognized in 2004 were $558,000,of which $206,000, $115,000, $38,000 and $199,000 were recognized in the first,second, third and fourth quarters of 2004, respectively.

 

The totalseverance related charge recognized in 2004 was $103,000, which was recognizedas $65,000 and $38,000 in the first and second quarters of 2004, respectively.The severance charge related to already separated personnel and personnel costsassociated with benefits expected to be paid upon completion of certaineligible transfer activities. Additional restructuring costs of $375,000associated with costs to exit certain production activities were alsorecognized in 2004, of which $141,000, $77,000, $38,000, and $119,000 wererecognized in the first, second, third and fourth quarters of 2004,respectively.  The charges relate toaccelerated depreciation on certain production related equipment to beabandoned after shutdown and contractual closing costs.

 

The buildingpurchase is reported as an asset held for sale and is being marketed for saleas APT no longer requires the space. In accordance with SFAS 144, an asset heldfor sale is carried at net estimated fair value. As such, APT recorded animpairment charge for the building in the fourth quarter of 2004 and 2003 ofapproximately $80,000 and $350,000, respectively. Fair value was estimatedbased on comparable sales data of similar commercial space in the area. The netcarrying value of the building as of March 31, 2005 was approximately $930,000and is included as a component of other current assets.

 

During the first quarterof 2005 an additional $45,000 was recognized in restructuring charges. Thecharges were associated with additional severance costs.

 

*Interestincome and o**ther expense, net*.  Interest income and other expense, net, whichincludes interest income, interest expense and other expense, was a net incomeof $4,000 in the first quarter of 2005 compared to a net income of $34,000 inthe first quarter of 2004. Net interest income was $55,000 in the first quarterof 2005 compared to $40,000 in the first quarter of 2004. Net other expense of$51,000 and $6,000 in the first quarter of 2005 and 2004, respectively,primarily included foreign exchange losses associated with the operations ofour subsidiary in Bordeaux, France.

 

*IncomeTax Expense (Benefit)*. During the first quarter of 2005, the Company recorded a tax expense of$30,000. Although the Company had a consolidated net loss, we recorded taxexpense for certain state income taxes owed. In the first quarter of 2004, the Company recorded no tax expense on the$283,000 of income before taxes. The Company recorded a full valuationallowance against its remaining net deferred tax assets in the fourth quarterof 2003. In assessing the valuation of deferred tax assets, SFAS No. 109 “Accountingfor Income Taxes,” requires a more likely than not standard. The ultimaterealization of deferred tax assets is dependent on the generation of futuredomestic taxable income during the periods in which the associated temporarydifferences become deductible. Management considers the scheduled reversals ofdeferred tax liabilities, projected future taxable income, and tax planningstrategies in making this assessment. Although the Company anticipates futurelong term profitability, SFAS No. 109 requires that recent historical operatingperformance weigh more heavily in assessing the valuation of deferred taxassets. The more likely than not assessment was principally based upon thelosses generated during 2002, 2003, and the first quarter of 2005 and thecyclical nature of the industry which make projections of industry trendsdifficult. While the Company has sufficient net operating loss carry-forwards(NOL’s) to offset federal taxable income for regular tax purposes, the Company’suse of its NOL’s for alternative minimum tax (AMT) purposes are limited to 90%of its AMT income (AMTI). Therefore, the Company expects to pay AMT ofapproximately 20% on the remaining AMTI, resulting in an approximate effectivetax rate of 2% on domestic taxable income. However, at such time the Company is able to 

 

18

----

 

determine if it is morelikely than not that it will be able to utilize its net operating losses, thereserve against the net deferred tax asset would be reversed.

 

**Liquidityand Capital Resources**

 

Management assesses the Company’s liquidity in terms of its ability togenerate cash to fund its operating, investing, and financing activities.Significant factors affecting the management of liquidity are: cash flows fromoperating activities, capital expenditures, investments in businesses, andaccess to bank credit when required and at reasonable rates.

 

*Operating Cash Flows:* In the first three months of 2005, we generated approximately $1.2 millionfrom operating activities. This resulted from our net loss of $6.3 millionoffset by $1.3 million of non-cash charges for depreciation, amortization, and provisions,$4.9 million for in-process research and development charges, and $1.3 millionfor reduced working capital requirements. The lower working capital requirementsreflected lower accounts receivable, inventory, and payables on lower revenue.

 

*InvestingCash Flows:* In the first three months of 2005, we used $3.9million in investing activities which primarily consisted of our acquisition ofPowerSicel, Inc., partially offset by net proceeds from the sale and purchaseof marketable securities of $1.6 million. The acquisition of PowerSicelconsumed approximately $5.0 million of cash and direct costs during the period,net of $460,000 cash acquired.  Inaddition, we issued APT stock options valued at $570,000.  We also purchased $492,000 of property,plant, and equipment during the period.

 

*FinancingCash Flows:* In the first three months of 2005, we generatedapproximately $21,000 from financing activities, which primarily consisted ofproceeds from the exercise of stock options.

 

As of March 31,2005, APT had $30.5 million in working capital. Our trade accounts receivable balance was $8.6 million reflecting a dayssales outstanding ratio of 60 days, compared to trade accounts receivable of $10.0million at December 31, 2004, reflecting a days sales outstanding ratio of 60 days.We expect our days sales outstanding ratio to range from 50 to 60 days,depending on the geographic mix of our revenue. Our inventory balance at March31, 2005 was $13.4 million reflecting inventory turns of 3.0 times per year,compared to an inventory balance of $14.6 million at December 31, 2004,reflecting inventory turns of 3.0 times per year. The Company continues tomonitor inventory levels and take action to improve inventory turns. Thecalculations above are based on quarterly average balances of trade accountsreceivable and inventory.

 

On March 31, 2005,we entered into a loan and security agreement with Silicon Valley Bank. Theagreement is for a $10 million revolving line of credit that bears interest, atthe election of the Company, at either the Silicon Valley Bank prime rate plusa margin or the LIBOR rate plus a margin. The margin for either rate is dependent on the adjusted quick ratio ofthe Company as defined in the agreement. The Company paid commitment fees of 20 basis points upon closing andwill pay 20 basis points per year on the unused portion of the line of credit,payable quarterly.  Amounts borrowedunder the credit agreement are secured by certain tangible and intangibleassets of the Company. The credit agreement expires on June 30, 2006, at whichtime all amounts borrowed and related interest are immediately payable if theagreement is not renewed.

 

We currently expect tofund our capital expenditures and liquidity needs primarily from a combinationof available cash balances and internally generated funds.  We also have a line of credit for $10 millionwith Silicon Valley Bank. As of March 31, 2005, APT had $12.5 million incash and cash equivalents and available-for-sale securities. APT’s investmentpolicy is to invest in short term, high-grade liquid investments with the goalof capital preservation. APT’s ability to generate positive cash flow fromoperations may be affected by market conditions as well as other risk factorsas described below. We expect from time to time to evaluate potentialacquisitions and equity investments complementary to our market strategy. Tothe extent we pursue such transactions, we could require additional equity ordebt financing to fund such activities or to fund our working capitalrequirements in the event of an industry downturn or an unexpected adversechange in our business operations. To the extent we require additional capitalwe cannot assure you that we will be able to obtain such financing on termsfavorable to us, or at all.

 

19

----

 

**OffBalance Sheet Arrangements & Commitments**

 

As of March 31,2005 the Company did not have any unconsolidated entities or off balance sheetfinancial arrangements, guarantees or similar commitments with such entities. Asof March 31, 2005 the open value of purchase order commitments was $13.9million compared to $12.1 million at December 31, 2004. This represents theamounts committed per open purchase orders with third parties. The increaseover the December 31, 2004 balance is primarily due to higher material andsubcontractor commitments after reducing our purchasing needs in the fourthquarter of 2004 to limit inventory build up, as explained in the *Gross Profit* section above. The Company did not enter orterminate any lease agreements during the quarter.

 

**ITEM 3****. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

We do not usederivative financial instruments in our investment portfolio. Due to the shortduration and conservative nature of our cash equivalents, and the high qualityand conservative nature of our long-term investments, we do not expect anymaterial loss with respect to our investment portfolio.

 

Currently lessthan 2% of our sales are transacted in local currencies, primarily Euros. As aresult, our international results of operations have limited exposure toforeign exchange rate fluctuations. We do not currently hedge against foreigncurrency rate fluctuations. Most of our export sales and sales by APT Europeare in U.S. dollars, and most of our foreign currency sales are from operationswith significant expenses in the same currency. As a result, gains and lossesfrom such fluctuations have not been material to our consolidated results ofoperations.

 

**ITEM 4.****CONTROLS ANDPROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

As required by new Rule13a-15 under the Securities Exchange Act of 1934, the Company carried out anevaluation under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures, as of the end of the period covered by thisreport. Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures are effective to ensure that information required to be disclosed bythe Company in the reports it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.

 

**Changes in Internal Controls overFinancial Reporting**

 

No change in ourinternal control over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) occurred during the first quarter of 2005 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

20

----

 

**PART II.**** OTHER INFORMATION**

 

**ITEM 6.****EXHIBITS**

 

The exhibits filed aspart of this report are listed below:

 
| **Exhibit No.** | ** ** | ** **                                                                                                                |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                      |
| 31              |       | Rule13a-14(a)/15d-14(a)  Certification, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.            |
|            |       |                                                                                                                      |
| 32              |       | Certification pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized this 10th day of May, 2005.

 

 
|   |   |   | ADVANCED POWER  TECHNOLOGY, INC.             |
|--------|--------|--------|----------------------------------------------|
|   |   |   |                                         |
|   |   |   |                                         |
|   |   |   | By:/s/ GREG M. HAUGEN                        |   |
|   |   |   |                                         |
|   |   |   | Greg M. Haugen                               |
|   |   |   | Vice President, Finance  and Administration, |
|   |   |   | Chief  Financial Officer and Secretary       |
|   |   |   | (Principal Financial  Officer)               |

 

21

----